How to Skew Bad Economic Data to Inspire Investor Confidence

As we begin a hopeful New Year, investors face a vast array of “knowns” and “unknowns.” Most of the knowns are uninspiring, at best.

But so what? The unknowns can be whatever we want them to be…at least until they become knowns. Here… Let us show you how easy it is to turn an uninspiring known into a truly inspirational unknown…

Earlier this week, the Institute for Supply Management (ISM) announced that its index of manufacturing activity was 57.0 in December – a slight increase from November’s 56.6 reading, but still well below the 60.4 number from last April.

Seems like an uninspiring report…until you pick up the following day’s issue of The Wall Street Journal. “Factory Activity Surged in December,” the Journal proclaimed. Based on the numbers, the Journal’s account is simply false. But that’s not what counts here. What counts is the Journal’s rose-hued assessment of future factory activity – i.e. the glorious unknown. In other words, factory activity did not actually surge in December, but it is probably going to in January, right?

Here’s another fascinating example of dream-weaving: late last week, Moody’s announced that commercial and industrial (C&I) lending squeaked out a 0.2% increase in the fourth quarter. Armed with this thoroughly uninspiring data point, The Wall Street Journal declared, “Banks Open Loan Spigot.” False.

The only spigot that’s open inside America’s largest banks is that one that pours capital into proprietary trading desks. As the nearby chart illustrates, the volume of “trading assets” at US banks has been soaring. These would be the same “trading assets” that have been producing the perfect and/or near-perfect trading results at Goldman Sachs, JP Morgan and others.

Is it any wonder, therefore, this portion of bank balance sheets is inflating, while traditional components – like actual loans – are either deflating or doing nothing? If you had access to cheap, subsidized government funding, along with simultaneous access to a quasi-monopolistic cartel on the sale of the government’s own securities, would you bother making a loan?…Nah, we wouldn’t either.

But we digress…

Let’s take a peek at another uninspiring data point. Just this morning, the Labor Department announced that initial claims for unemployment during the past week increased by 18,000 to 409,000 newly unemployed individuals. Bloomberg News responded with the twin headlines, “Unemployment Claims Over Past Month Drop to Lowest Level Since July 2008,” and “Dollar Rallies on Optimism Over Stronger Job Market.”

See how easy this is? If you get a tepid factory utilization report, no problem. Call it, “US Factories Ready to Power Ahead as Economy Gathers Steam.” If you get a lousy retail sales report, don’t worry. Describe the setback as, “Blizzard Impedes Resurgent Consumer Spending.”

Go ahead; try it at home. It’s fun for the whole family.

You could say that investors are good at making something out of nothing. But isn’t that also what LSD accomplishes? Outside of the financial realm, chronic self-delusion usually requires some combination of therapy and/or rehab. But inside the financial realm, self-delusion is not only normal, it is often very profitable…at least for a while.

“What is fascinating in the markets,” economist David Rosenberg observed recently, “is that so many people can be right despite all their assumptions and lines of reasoning being totally off-base. That was the case in 2010 – go back to the consensus in Barron’s a year ago and you’ll see that the bullish prognostications at the time were optimistic because of visions of a sustainable V-shaped recovery taking hold.” The Dow rallied about 13% during the year, even though a V-shaped recovery never materialized.

But that was last year. What about this promising new year?

Well, as Rosenberg points out, a short list of knowns provides little comfort:

1. Stubbornly high unemployment rate (at 9.8%, not far off the recession high of 10.1%)… Continuing claims today, at 4.1 million, compared with 3.1 million back in 2008; extended benefits today are at 819,000 versus zero back then…

2. Deflating home prices – in fact, not only did Case-Shiller home prices decline 1.3% month-over-month in October, but all 20 cities showed a sequential decline, and this last happened in February 2009…

3. Huge state/local government budget gaps ($65 billion this year) will be closed with tax hikes, user fees and service cutbacks. The biggest myth being promulgated today is that the economy must be doing better because state/local government revenues are on the rise. Dude! That’s not the economy! It’s called tax increases…

4. Surging energy prices – oil prices have broken above $90 a barrel…

5. Slowing global growth, as flagged by the decline in the Chinese stock market…

“From our lens,” Rosenberg concludes, “at current valuations, the good news appears to be fully priced in and then some.” Nevertheless, Rosenberg admits, “[Only] a fool would say that this overextended market could not become even more extended in coming months.”

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About Eric Fry:

Eric J. Fry, Agora Financial’s Editorial Director, has been a specialist in international equities for nearly two decades. He was a professional portfolio manager for more than 10 years, specializing in international investment strategies and short-selling. Following his successes in professional money management, Mr. Fry joined the Wall Street-based publishing operations of James Grant, editor of the prestigious Grant’s Interest Rate Observer. Working alongside Grant, Mr. Fry produced Grant’s International and Apogee Research, institutional research products dedicated to international investment opportunities and short selling.

Mr. Fry subsequently joined Agora Inc., as Editorial Director. In this role, Mr. Fry supervises the editorial and research processes of numerous investment letters and services. Mr. Fry also publishes investment insights and commentary under his own byline as Editor of The Daily Reckoning. Mr. Fry authored the first comprehensive guide to investing internationally with American Depository Receipts. His views and investment insights have appeared in numerous publications including Time, Barron’s, Wall Street Journal, International Herald Tribune, Business Week, USA Today, Los Angeles Times and Money.